Price for value, not cost

Knowing what to charge for your startup’s product is hard, but you should always price for the value it creates for your customers, not how much it costs you to provide it.

The current standard in SaaS is some version of three-tiered pricing – small, medium, and large (or enterprise) plans, with each progressive tier giving the customer increased access to the number of accounts they can have, emails sent, API calls made, etc. Typically, an increase in price is correlated with an incremental cost increase for the provider rather than tied to the value that the user is getting from the product.

Imposing this “step function” pricing implicitly says, “Every one of my customers is going to fall neatly into one of these three buckets.” In reality, within one product, the value each customer gets from using the product falls along a spectrum.

In the graph above, every single point on the line represents a customer and the amount of value they’re extracting. Some customers may log in once a month, while others spend eight hours a day, five days a week living in your product. If you only have small, medium, and large plans, you are creating a difference between the value they get and how much they pay you, because each plan has an upper threshold for cost. Ironically, unlimited plans are the worst offenders. They’re essentially designed to give the largest customers, often with the most means to pay, the largest discount.

If your product is unique, the “value curve” that it forms is also unique. It makes little sense to price it the same way as hundreds of other SaaS businesses.

Capturing the value to your customer

To price well, you have to be able to capture the value your customers are receiving across the spectrum. That variable is different for everyone. So a company like LinkedIn – whose mission is to “connect the world’s professionals” – wouldn’t monetize on the number of connections that people added, because that would discourage people from connecting. Their users get the most value from the results of communicating with others in their network, so LinkedIn charges on messages sent between connections.

Once you’ve proven people are willing to pay something for your product, it’s a good time to revisit your first pass at pricing. Like with building product, the first steps can be small; not everyone has the resources and time to build a billing system. But it’s never too early to start thinking deeply about what types of behaviors you want to incentivize with your pricing structure.